Deconstructing ESG Ratings Performance: Risk and Return for E, S, and G by Time Horizon, Sector, and Weighting

• Published in: Journal of portfolio management Vol. 47; no. 3; pp. 94 - 111
• Main Authors: Giese, Guido, Nagy, Zoltán, Lee, Linda-Eling
• Format: Journal Article
• Language: English
• Published: London Pageant Media 01.02.2021
• Subjects: Carbon; Financial analysis; Incentive plans; Ratings & rankings; Social investing; Valuation; Volatility
• DOI: 10.3905/jpm.2020.1.198
• ISSN: 0095-4918

There are many ways to construct a company’s environmental, social, and governance (ESG) score or rating, involving different combinations of financial and nonfinancial inputs. Determining the most influential criteria for firm performance may be overlooked in the rush to “do some ESG.” In this study, the authors deconstruct ESG ratings performance at the E, S, and G pillar levels and use the most common key issues indicators that underlie ESG scores. They find that the time horizon used has an important bearing on the indicators’ significance. In the short term, they find that governance is the dominant pillar because it strongly reflects event risks, such as fraud. In the long term, however, environmental and social indicators became more important because issues such as carbon emissions tended to be more cumulative, presenting erosion risks to long-term performance. The authors also find that a more balanced and industry-specific weighting of E, S, and G issues showed better long-term relevance than the individual pillar indicators alone. TOPICS: Equity portfolio management, ESG investing, pension funds, foundations & endowments, performance measurement, wealth management, risk management Key Findings ▪ Aggregating environmental, social, and governance pillars into a total ESG rating added value in terms of performance and risk. ▪ Governance indicators showed the greatest significance in the short term because they have tended to materialize as event risks that immediately affected stock prices. ▪ However, some E and S indicators have developed slowly but have had long-lasting financial effects (erosion risks).